Mortgage Refinance and Tax Implications

Refinancing a mortgage is the act of taking out another mortgage plan in order to pay off the present mortgage plan that a person has on his home. This may sound a bit complicated, but it actually is not. In fact, refinancing your mortgage is indeed a reasonable move for a lot of people. If you know the ropes, you can even end up saving thousands of dollars more than you would by just continuing your current mortgage.

There are a lot reasons why a lot of people resort to refinancing their mortgage plans. The most common of these reasons is, as expected, the opportunity to save money. The concept here is to find a loan option that has a lower interest rate compared to that of your mortgage plan. That way, your monthly mortgage payments, as well as the interest that you will be paying, will become significantly less.

But before you go about the refinancing of your mortgage plan, you should first check if your present plan has a prepayment penalty applied to it. This is because if your existing mortgage has a prepayment penalty, then you would have to pay off a certain percentage of that loan if you decide to pay it off early through the refinancing of your mortgage plan. This would mean more costs for you, in the long run. So, it would actually be better to wait for the time when prepayment penalties cease to apply to your mortgage.

Another thing to remember when considering the refinancing of your mortgage is taxes. There are actually three tax considerations to remember. Firstly, when you decide to refinance your mortgage plan, you will inevitably be paying lower interest rates. This would then lead to less interest that will be deducted from your income tax return. And with less deduction, your tax payments will inevitably increase as well. The total savings from your new mortgage bearing lower interest rates would also be decreased.

The second thing to consider is the fact that the loan origination fee and the discount points are actually tax deductible. That is, if these were for the costs of general processing, and not for specific costs. Now, the Internal Revenue Service, or the IRS, has established a policy concerning interest points that have been paid in advance for refinancing. The IRS has placed that these interest points be spread out for the duration of the mortgage plan. So, the process of deducting points would be affected here. However, there is an exception to this rule: points can be immediately deducted if the proceeds coming from the refinancing would be used for the refurbishment of your property. And this refurbishment should be substantial as well. To be sure where this ruling stands today, it would be better to check with the IRS for updates on this.

The third consideration concerns the 1986 Tax Reform Act. With the 1986 Tax Reform Act, there are no changes for interest, mortgage, and points. All of these aspects will still be deductible. However, there is the possibility of you being in a lower tax bracket. If you are in such a position, you might want to consider getting mortgages of shorter terms. To make the most of this act, it would be better to consult your tax adviser first.